By Jim Donnelly, Olson Global Markets
Ahead of the October jobs report due for release this Friday, a cluster of talking points last week centered on whether the equity markets are now developing a bubble. In the absence of a correction of more than 8% this year, and along with the perception that there is a race to outperform market averages before year-end by investment managers who have fallen behind their benchmarks, bubble worries appear to be growing. All-time high levels of margin debt on the NYSE also suggest to some that leveraged equity positions are to blame for the largely uninterrupted rise in stock prices. Others point out on the other hand, that margin debt on the NYSE as a percentage of total market capitalization, while high at 1.6% has not yet reached the 2008 all-time high of just above 1.8%.
Aside from these observations, there is a chart that also has investors worried. It is the long-term (monthly) chart of the Dow Jones Industrial Average (on a linear scale), which shows the DJIA now approaching a test of key long-term trend line resistance currently sitting at 16,120. By definition, this trend line connects the previous peaks of both the Tech Bubble of 2000-2001 and the Housing Bubble of 2007-2008, which were each followed by devastating selloffs in equity prices.
From a fundamental point-of-view, what could trigger the bursting of this potential equity bubble? Perhaps, there will be a decline in forward earnings expectations. Maybe there will be a showdown in the Middle East pitching Israel versus Iran. Possibly additional creation of more low paying part-time jobs will come at the expense of a decline in higher paying full-time earners. Maybe there will be a retreat in domestic consumption accompanied by a growing deflationary threat. There could be a hint of: the beginning of a trade war; a weakening European banking system; a surprise change in tactics by a new Fed Chairwoman; or a collapse of Obama-care. Or maybe none of the above will emerge at all. No one really knows.
Nevertheless, a wary eye on the Dow Jones Industrial Average as it approaches key technical resistance now at the 16,120 level might be a better overall gauge as to whether the market is actually developing a bubble that is ready to burst …or not!